Business Cycles Ends With Recessions

Key Concepts

• Business Cycle: The recurring pattern of expansion and contraction in economic activity.
• Recession: A significant decline in economic activity spread across the economy, lasting more than a few months.
• S&P 500: A stock market index representing the performance of 500 large-cap companies in the United States.
• M2 Money Supply: A measure of the total amount of money in circulation in an economy.
• Federal Funds Rate (FFR): The target interest rate set by the Federal Reserve.
• Inflation: A general increase in prices and fall in the purchasing value of money.
• Negative Feedback Loop (in Recession): A cycle of layoffs, reduced spending, and further layoffs, exacerbating economic decline.
• Midterm Year Weakness: A historical tendency for stock market weakness during the second year of a presidential term.
• ITC Recession Indicator: A proprietary metric developed by Benjamin Cowen combining S&P 500, unemployment, interest rates, inflation, and M2 money supply.
• Soft Landing: A slowdown in economic growth that avoids a recession.
• Hard Landing: A significant economic downturn resulting in a recession.

Late Business Cycle Dynamics and Recession Indicators

The video centers around the argument that the current economic environment is indicative of a late-stage business cycle, increasing the probability of a future recession. The presenter, Benjamin Cowen, details a proprietary indicator – the ITC Recession Indicator – designed to visualize this risk. This indicator is calculated by dividing the S&P 500 by the unemployment rate squared, multiplied by the inflation rate and interest rates, then divided by the M2 money supply. Historically, the indicator has peaked before recessions, though the stock market peak doesn’t always coincide with the indicator peak. For example, the indicator topped in May 2006, while the stock market continued to rise until 2008. Similarly, in 2000, the indicator and S&P 500 topped around the same time, but in 1990, the indicator peaked while the S&P 500 continued to climb before a 20% drop. A 20% drop is characterized as a “soft landing” versus a “hard landing” recession.

Normalizing the Indicator with Money Supply (M2)

Cowen explains that the original indicator might be missing a crucial element: liquidity, represented by the money supply (M2). To address this, he normalizes the indicator by dividing it by M2. This adjustment reveals a pattern suggesting that the current economic excess, fueled by pandemic-era money printing, is diminishing. While the chart’s historical data only extends back to 1980 on TradingView, the normalized chart still provides valuable insight, indicating that the current situation is not the start of a new business cycle, but rather the end of one. He emphasizes that the chart suggests we are in a late business cycle, making a recession likely within the next 2-3 years, potentially sooner.

Current Economic Data and Recessionary Signals

Despite currently positive real GDP and low initial unemployment claims, Cowen argues that the stock market may begin pricing in a recession soon. He highlights the importance of monitoring the negative feedback loop – a cycle of company layoffs leading to joblessness, reduced spending, and further layoffs. Currently, layoffs are low, and job openings are declining, but hiring remains abysmal, similar to levels seen in 2017. This suggests a potential for a future negative feedback loop. He notes that the stock market often begins to decline before the negative feedback loop fully manifests, meaning the market could price in a recession before it is officially declared. He references past recession statistics, noting that the S&P 500 typically bottoms approximately 15 days before a recession is officially announced.

Risk Asset Performance and the Business Cycle

Cowen discusses the typical performance of different risk assets throughout the business cycle. He argues that the riskiest assets, like altcoins, tend to bleed first, followed by Bitcoin, then the stock market, and finally, more defensive sectors like energy and precious metals. He points out that altcoins have been declining since the end of 2021, even as the ITC indicator has been falling. Bitcoin has followed suit more recently. He suggests that Bitcoin’s current weakness may already be pricing in the anticipated recession. He also notes that energy (XLE) historically holds up well even as other sectors decline, often topping out after the broader market has begun to fall.

Midterm Year Dynamics and Potential Timelines

The presenter emphasizes the historical weakness observed in midterm years (the second year of a presidential term). He notes that the window of weakness typically occurs between March and October. He suggests that if the stock market experiences a typical midterm year drawdown, it could trigger the negative feedback loop and accelerate the arrival of a recession. He posits that the business cycle could end between 2026 and 2028, with a possibility of an earlier conclusion. He highlights the importance of monitoring initial unemployment claims; a significant increase could signal the onset of a recession.

Bitcoin’s Four-Year Cycle and Market Narratives

Cowen connects the business cycle analysis to Bitcoin’s well-known four-year cycle. He suggests that Bitcoin’s current downturn may be aligned with this cycle and the broader economic context. He cautions against relying on narratives and headlines that emerge after a recession has begun, as markets tend to price in events ahead of time. He advises investors to ignore the bullish narratives that often surface during market downturns, as they are often driven by those who are already invested and have a vested interest in a positive outcome. He emphasizes that the current price of Bitcoin is roughly the same as it was in 2021, highlighting the lack of substantial gains despite the narratives of a “supercycle.”

Actionable Insights and Hedging Strategies

Cowen recommends a cautious approach, suggesting that investors should be selective with their investments in a late business cycle environment. He specifically advises against investing in altcoins. He advocates for hedging strategies, potentially shifting from riskier assets to safer ones, and maintaining cash reserves to capitalize on potential buying opportunities during a market downturn. He also points to his website, benjamancow.com, where he offers macro risk memos and consulting services.

Notable Quote:

“Bare markets make fools of both bulls and bears.” – Benjamin Cowen, emphasizing the difficulty of accurately predicting market movements during downturns.

Conclusion

The video presents a compelling case for the likelihood of a recession within the next few years, supported by a proprietary indicator, analysis of economic data, and historical patterns. Cowen stresses the importance of understanding the late-stage dynamics of the business cycle and positioning portfolios accordingly. He advocates for a cautious approach, emphasizing the need to monitor key indicators, avoid overly optimistic narratives, and prepare for potential market weakness. The core takeaway is that the current economic environment warrants increased vigilance and a proactive approach to risk management.